• Despite Awareness Campaigns, Institutional Investors Still Fail to Collect Settlements
  • March 1, 2005
  • Law Firm: Berman DeValerio Pease Tabacco Burt & Pucillo - Office
  • Institutional investors are letting billions of dollars slip through their fingers, failing to submit claims forms in the vast majority of securities class action settlements, a new study shows.

    The analysis -- a follow-up to a pilot study published two years ago -- found that financial institutions with significant, provable stock losses fail to file claims 70% of the time. The latest numbers from professors at Duke and Vanderbilt University law schools highlight fundamental flaws in the compensation mechanisms for defrauded investors.

    According to the researchers, institutions are missing out on average median recoveries of more than $90,000 per settlement. "To our eyes, this would seem to be a significant return on the small costs (in terms of time and money) of filing a claim in a securities fraud class action," the report said. "Of course, the institutions with the largest holdings would realize far more than this from filing claims."

    In a draft paper released in January in conjunction with Institutional Shareholder Services, professors James D. Cox of Duke and Randall S. Thomas of Vanderbilt explore several reasons why the claims filing rate is so low. Chief among them: poor monitoring of settlements and communication breakdowns between custodians and institutions. Other factors include mechanical failures in the notification and recordkeeping processes; the time lag between the corporate fraud and the eventual settlement; and the (misguided) belief among portfolio managers that only investment activities produce worthy returns.

    The study's authors can hardly be accused of class action boosterism. They articulate strong reservations about the compensatory function of securities fraud cases, calling into question the "serious mismatch" between the settlement's beneficiaries and those originally harmed by the securities violations. "Simply stated, many defrauded beneficiaries are not compensated for their losses, while others are unjustly enriched," they write.

    Nevertheless, Cox and Thomas believe that funds should take advantage of settlements when there are provable stock losses. Fiduciaries and custodians who neglect to file claims are failing their funds and their beneficiaries. "We believe that the trustees of institutional investors must, in good faith, insure that their fund has an adequate system in place to identify and process the fund's claims."

    The researchers surveyed institutional investors about their claims filing practices, asking who was responsible for the task, how it was performed and what, if any, monitoring was done. They found that most institutions relied on their custodian banks to file their claims; that many of the institutions did not monitor whether the custodian had in fact done so; and that custodians had financial disincentives to file claims on behalf of their clients.

    The authors suggest several ways to improve the filing rate.

  • Creating a centralized information clearinghouse or Web site for settlement notices and claims forms.

  • Adopting standardized claims forms and trading documentation to facilitate the filing process.

  • Improving monitoring by institutional investors of custodians that handle claims forms.

  • Establishing clear guidelines concerning claims filing practices and fiduciary duties.

    According to the study, one of the key factors contributing to the poor claims record is the fact that settlement notices are rarely sent directly to an institution, forcing investors to rely on publication notices or their advisors. The obvious solution? Send notices straight to the stockholders.

    To do this, however, the Securities and Exchange Commission would need to make its filing methodology more transparent and accessible. And to protect confidentiality concerns, the professors propose that the SEC develop an electronic system that would forward settlement notices through the regulatory agency directly to the shareholders. The original pilot survey had been based on questionnaires completed by 12 institutional investors. With those results in mind, the researchers designed a second, more detailed survey on institutional claims filing practices. To the several hundred surveys sent to institutions in 2003, the researchers received 23 replies: 20 from public pension funds; two from private pension funds; and one from a bank.

    The authors reached their conclusions through the questionnaires and an empirical study of 118 securities fraud settlements.